Economic Slowdown and Insights from Behavioural Economics

Image Source: National Herald

It took quite some time for economics to get out of its rational driven positivist mode. Several economists approached economics like Physics. Although economics is a human science and as such dealt with human activity directed to the managements of the oikos (home) with the nomos (rules) that were most efficient, it somehow approached humans as particles in Physics whose activity might be described by a few well understood rules. The economists knew that we are not always rational actors in the market. But they considered that in the long run their positivist method would give a good approximation of the economic reality. Thanks to the work of Richard Thaler and others, the emergence of behavioural economics has come to fill some of the gaps that were left by the rationally driven positivist economics. Besides that fact that Richard Thaler bagged the all important Noble prize of economic sciences for 2017, demonstrates that behavioural economics cannot be set aside anymore. It becomes significant because it studies the social, psychological and emotional factors that influence economic behaviour of people. This way of looking at economics is not entirely new. The seeds of this science may be traced in the theory of moral sentiments of Adam Smiths. We all know the role played by perception in the market. Behavioural economics suggests that besides perception, passion also plays a remarkable role in the market. No economic bubble can be fully explained by pure rational logic. But it can be adequately explained by what economist John Maynard Keynes called rush/increase of animal spirits (passions).

Markets have exploited the psychology of decision making for a long time. Psychological pricing is often used to make people feel that they are getting a good deal. A price tag of Rs 499 often wins over its counterpart that tags Rs.500. But sometimes people are willing to pay a higher price to feel that they are paying for high quality goods. Often, cars that are high priced become status symbols. Along with the above complex human behavioural patterns in the economic arena, we have what economists call the nudge theory. Nudges encourage the people to act in a particular way without actually changing the choices that are available to them. Thus, for instance, the behavioural economists suggest that the items that one wants to sell quickly, one has to place into the eye level shelves while others that can wait can be sent to less convenient places. It is found that nudge theory works. Maybe demonetisation in our country produced a nudge effect on all of us. It might have given us the energy to stand in long lines for hours together. The behavioural economists point out that we humans are bad losers. Wining gives us pleasure and losing gives us pain. We are more concerned about pain and hence try to avoid the prospect of loss. Most of us have gone through the pain of having to pay a fine for breaking traffic laws. Loss aversion is at work when people try to avoid paying taxes to the Government. Maybe in this light we can see why GST has set in a sense of loss among the consumers as well as the traders and service providers.

The pain of paying is an important factor that affects our behaviour with money. When we go for dinner, we have an option to pay by cash or credit card. Almost all humans feel the pain more when they pay cash. With the implementation of GST, given the high tax on food, it feels like the Government is also sitting at table to eat with us. Behavioural economists teach that the pain of paying adds a moral tax on our consumption that is why it changes how we feel about the payment. Sudden demonetisation has released the pain of paying in our country. But the fact that it was given a moral motive to fight black money, terror funding and the like, it had ameliorated the pain to a large extent. But when we learnt that the Government found no black money after that long ordeal, it brought loads of pain back. It seems to have made us feel that our Prime Minister has blown our money away. The economic slowdown that we face today has added to the pain. Here we are not really physically paying anything yet we have pain of paying that makes us feel that we are collectively losing something.

Demonetisations and messy implementation of GST have been accepted as big blows to our economy by all and sundry. It seems that the Prime Minister’s advisory committee of economic affairs is also largely on the same page with regard to economic slowdown. The World Bank has predicted that our GDP will steadily grow to reach 7% by 2020. All these assessments are based on classical economic models. Behavioural economic model on the other hand will try to understand how both demonetisation and hasty implementation of GST have given death blows to motivation and productivity of all Indians. The fact that noble goals of demonetisation were doomed; the entire exercise lost meaning and became exploitative. This certainly lowered the moral of Indians. Besides, the non-performing assets (NPAs) have become a hard mountain to climb and there is no sign of any remedial action. Add to this the unpleasant feeling of being cheated by bank defrauders who have left our country. We have all the ingredients that have produced the conditions that have destroyed the enthusiasm of Indians. The road to recovery seems to be hard and difficult but not impossible. We need to add the insights of behavioural economics to the principles of classical economics. In the light of behavioural economics we have to admit that the recovery does not exist in our tomorrow, but in our today.

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